A friend who is a rocket scientist (literally) at NASA once asked a simple question that most value investors would consider blasphemy: "So what's the big deal about Warren Buffett, anyway?" But it's a fair question, and it's worth answering.
The longtime Berkshire Hathaway chairman's mystique starts with his track record. With a net worth of $62 billion (and counting) by Forbes's reckoning, Buffett is the wealthiest person on earth, a position he achieved by producing perhaps the greatest long-term investing record in history. Thus, any investor who fails to learn as much as possible about how he achieved this success is, to use a favorite word of Buffett's partner, Charlie Munger, "bonkers."
MORE DISCOVERING VALUE
||What Value Investors Value|
||Fixes for Bad Timing|
There is a certain purity to the way Buffett has built his fortune. No exploitation of the masses, no monopolies, no giant inheritance. Simply by buying stocks, and later companies, over more than 50 years, he's turned his paperboy earnings into a fortune. Markets ruthlessly separate winners from losers, and no one has won bigger than Buffett -- ever. That's a big deal.
A real mensch
But Buffett's appeal goes far beyond the fact that he's rich. Roger Lowenstein wrote in his biography of Buffett that his "character and career unfolded as a sort of public tutorial on investing and on American business." His willingness to share of himself and his knowledge gives his followers the impression that we know him and that he's speaking to us directly as he conducts this "tutorial." Is there another public figure -- a movie star, a politician, a CEO -- of whom we can say the same? Not that we can think of.
The way Buffett communicates -- with charm, clarity and wit -- also draws us to him. Others may have comparable insight, but he articulates it in a way we remember and quote endlessly. His description of competitive advantage as a "moat" is one example, as is this response to a student who planned to take a high-paying job before pursuing a more fulfilling career: "That's like saving up sex for old age." He even offers personal advice on how to be a better person: "You should think about what you like in other people and admire about them. Then ask yourself which of these traits are ones you physically or mentally can't have. The answer is none."
So what are the core elements of Buffett's ongoing investing tutorial? While it's impossible to reduce decades of investment wisdom to a few bullet points, here are a few of his investing tenets we try to abide by:
1. A share of stock is a share of a business. Lost at times in the breathless tracking of daily highs and lows is the fact that the value of a company's shares is ultimately tied to the free cash flow it can generate over time. That means you should put considerable emphasis on researching a company's strengths and weaknesses, the competitive dynamics of its industry, and how likely it is that in ten years its business will not be truly different than it is today.
2. Stick to what you know. Buffett often speaks of the importance of staying within your circle of competence when investing. "They don't give bonus points for difficulty," he says, so if you don't understand how a company makes money, go elsewhere.
3. Ignore the "cheery consensus." Independent thinking is not just helpful in becoming a successful investor, it's required. Conventional wisdom is already built into a stock's price, so if you find yourself agreeing with it, your upside will be limited. Or, as Buffett puts it: "You pay a very high price for a cheery consensus."
4. Value can mean many things. By his own admission, early in his career Buffett focused much more on quantitative measures of a stock's cheapness -- a low price-earnings or price-to-book-value ratio, for example. Over time (and with the prodding of partner Munger), he also recognized the tremendous value inherent in a company's ability to generate sustainable growth -- insight that helped lead him to the likes of American Express, Coca-Cola and Gillette.